Accounting - Chapter 1

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Chapter 1: The Accounting Environment – What is Accounting and Why is it Done?

Accounting is a system for gathering data about an entity’s economic activity, processing and organizing the data and in turn, communicating that information to people who want to use it to make decisions.

Data are unprocessed facts about an entity’s economic activity that is entered into an accounting system whereas information results from organizing and presenting the data in ways that make it useful for decision making by stakeholders.

Financial Accounting provides information to people who are external (investors, lenders, taxation authorities (CRA), competitors) to an entity.

Managerial Accounting provides information to internal users (managers) of an entity for decision making. It assists in operating decisions such as price setting, expansion, evaluating which products are successful and which aren’t, and determine the amount of a product that should be produced.

Accounting matters because it has economic consequences (choosing certain accounting method can result in gaining more money or losing more money – which one do you choose).

People need good accounting information to make good decisions about a business strategy.

Cost benefit trade-off is the concept of comparing the benefits of an action with its costs and of taking the action only if the benefit from it exceeds the cost of it. More information leads to better decisions, however, there are limits. Gathering and processing data is costly and time consuming. At some point, the benefit isn’t worth the cost. Too much information can impair a person’s ability to make decisions.

There are four key components of the accounting environment (accounting should be responsive to the environment and the people using the information): overall environment, entities, stakeholders and constraints.

Environment
Political, cultural, economic, competitive, regulatory and legal parameters differ from country to country.Entities Business entities include corporations, proprietorships, partnerships, not-for-profit organizations, governments and individuals. Characteristics of Entities

Each entity has different characteristics even though they might be operating in the same industry Size, ownership structure, Public vs. Private, distribution channel (Refer to pg 7)Constraints How an entity accounts for its economic activity and what information it reports aren’t entirely up to the preparers. The choices are constrained by contracts, laws, accounting rules and the information needs and demands of powerful skateholders

Corporations
A separate legal entity
Have many of the same rights and responsibilities as individuals (for ex. They must file tax returns, can be sued and enter into contracts (to borrow money). Ownership is represented by shares and owners of shares are called shareholders (investors). Provides limited liability to shareholders- shareholders are not liable for the obligations and losses of the corporation Share ownership is easily transferred to new owners without affecting the daily business activities. A transfer of ownership can be more difficult for other types of entities. Shares of public corporations can be bought and sold (traded) on a stock exchange (a place where shares of publicly traded entities can be bought and sold. The shares of private corporations are not available for purchase unless the entity or its shareholders agree.

Proprietorships
Unincorporated business with one owner
Isn’t a separate legal entity
Doesn’t pay taxes, owner includes the money earned by the business in his personal income tax return Unlimited liability – the owner’s personal assets can be seized to pay its creditors in case the proprietorship doesn’t meet its obligations Easy and inexpensive to set up

Partnerships
Unincorporated business owned by 2 or more partners ( e.g. people or corporations) Don’t pay taxes,...
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